Pension system reform facing rapid aging : lessons from China

Abstract

Pension reform is certainly the most complex of all structural reforms because it upsets existing political-economy equilibria, affects public finances, intervenes in the functioning of labor and capital markets, distributes income both across and within generations, and changes an economy's saving, investment, and growth paths from the short to the very long term (Schmidt-Hebbel 1999). Therefore, the impact of a pension reform on capital accumulation, saving, output, labor participation, income distribution, and individual welfare have long been of critical concerns to both academic economists and policy-makers. Since the early 1990s, China's national pension system, one of the largest pension systems in the world1, has undergone quite a few major fundamental reforms and been shifting from a traditional Pay-As-You-Go (PAYG) system to a Partially Funded (PF) multi-pillar system under an era featuring rapid economic growth and drastic demographic change. Given its complexity, scale, and importance, the practice of China's pension reform provides a good research case to study the macroeconomic and welfare effects of the type of pension reform from PAYG to partial funding. This dissertation presented in three essays aims to investigate the macroeconomic and welfare effects of China's pension reform, to review the progress and challenges facing China's pension systems, and to study some options for further parametric pension reform. It is worthy to note though our model targets China's pension reform, it is also suited to studying the type of pension reform from PAYG to partial funding in other countries. Essay one is the first of kind to use Auerbach--Kotlikoff framework to assess the macroeconomic and welfare effects of China's pension reform when population aging and transition costs are considered. We first build a two-period Overlapping Generation (OLG) Simulation Model in a general equilibrium framework with homogeneous agent under the context of population aging and endogenous labor force participation of the elderly to simulate quantitatively the two economies under PAYG system and PF system respectively. Then we analyze and compare the two economies at steady state to observe the effects of China's pension reform on capital accumulation, saving, output, wage, interest rate, lifetime utility, and income distribution. Our analysis shows China's pension reform from PAYG to partial funding has notable and positive effects on China's macro economy and intergenerational equality. Simulation results show impact of China's pension reform can be substantial. For example, under the cases of endogenous labor force participation of the elderly, the capital stock rises by 14%, output by 5.5%, national saving rate by 17%, real wage by 5.5%, lifetime income by 9.9%, and pension replacement ratio by 70%. Moreover, the reform significantly improves intergenerational fairness by reducing upward intergenerational transfers by 24%. Additionally, although the Reform brings up certain transition costs, the government can make appropriate policy measures such as imposing special consumption tax on consumer to deal with the challenge of financing the transition costs. Finally, the economy reaches its new steady state five periods after the Reform, yet the future generations gain at the cost of the transition generation's welfare loss, which may cause a challenge to the implementation of the pension reform. In order to make our model more suited to China's reality, the second essay extends the two-period OLG General Equilibrium Model with heterogeneous agents to study the effects of China's pension reform on macro economy and intergenerational and intragenerational income distribution. We assume two types of agents differ in their human capital endowments and in their access to the financial system. We first build the two-period OLG general equilibrium model and quantitatively simulate the economic effects of China's pension reform on macro economy, individual welfare, income distribution, and transition costs, then we discuss the sensitivity level of the simulated results to some important parameters, finally we analyze the specific transitional path of the Reform.